If You are Long the Broad US Stockmarket - Prepare to Get Buried

Fundamentally the rally in the broad stockmarket from early in March is viewed
as being the result of a combination of media hype, wishful thinking and short
covering, but there may be more to it than that - it would appear that a sizeable
proportion of the TARP (Troubled Asset Relief Program) funds not thus far deployed
have been used to drive up the stockmarkets in order to create a positive environment
for the banks to issue secondary shares and thus raise equity. While this is
perfectly understandable, it also means that once the banks have finished selling
this stock to the public, or the market is simply exhausted by being soaked
in this way, it is likely to go into reverse in a big way.

Technically, the rally in the broad stockmarket looks to be over and there
are several important reasons to conclude that this is the case. On the 1-year
chart for the S&P500 index we can see that despite the impressive gains,
all the market has managed to do is rally from an extremely oversold position
to approach its falling 200-day moving average, and so there is no reason thus
far to consider that it is anything other than a typical bearmarket rally,
albeit a big one. The rally stalled out a couple of weeks ago in the important
zone of resistance shown and the index has since been retreating beneath the
200-day moving average, and late last week it started to break down from the
uptrend in force from mid-March, a bearish development.

On the 6-month chart we can examine recent action in more detail. On this
chart we can see that the breakdown from the uptrend occurred on Thursday,
although thus far the break is not big enough to be conclusive, so we could
yet see a short-term rally back towards the 920 area, especially as the fast
stochastic (not shown) has dropped back to provide the leeway for such a move.
However, the trendline break still has bearish implications that are definitely
amplified by the growing preponderance of downside volume over the past couple
of weeks, as shown by the red volume bars at the bottom of the chart, which
has led to the first significant drop in the On-balance Volume line since the
uptrend started, another negative sign. In addition a bearish "shooting star" candlestick
appeared on Wednesday, when the market attempted to the challenge the early
May highs and failed, dropping back to close near the day's low. A top area
appears to be forming between the rising 50-day and falling 200-day moving
averages, which are rapidly converging. This top area is bounded by the resistance
shown and a support level which has become evident in the 880 area, breakdown
below which would likely trigger a steep decline.

The abnormal and surreal nature of the recent rally is made starkly clear
by the small charts below, prepared by www.chartoftheday.com. Both of these
charts go way back to the 1930's and the first of them shows the extraordinary
collapse in earnings of the S&P500 companies. The second of them shows
that the resulting overall P/E ratio has risen into the stratosphere. These
charts are most interesting as they demonstrate that earnings no longer matter
to investors - all it takes to make the market go up these days is hope, TV
commentators talking the market up - and a big dollop of TARP money. This is
what is commonly known as a disconnect from reality. One thing is for sure
- you don't want to be around when the market suddenly realizes that Barack
Obama is not going to be able to wave a magic wand and make everything right,
even with the benefit of creating trillions of dollars out of thin air to bid
everything up. All this manufactured money had better create a recovery soon
or the market is likely to implode. However, recovery is unlikely for, as we
know, the banks are jealously hoarding their government granted largesse, and
even if they made the funds available to the wider world, companies and individuals
are so lamed by debt and fearful that they are in no mood to borrow, no matter
how low the interest rate. So let's put 2 and 2 together - the stockmarket
rallies hugely to discount recovery, but the recovery never materialises. Well,
what a shame - it's an awful long way down from here.

Some market observers have been making comments in the recent past to the
effect that leveraged ETFs are a scam designed to sluice money from retail
investors into the pockets of professionals. While we would concur with this
it shouldn't really be surprising, as to the extent that they are a scam they
are simply following the rich tradition of many Wall St financial instruments,
and compared to sub-prime mortgages, for example, they are a "mom and pop" operation
as many European banks and financial institutions still smarting from immense
losses will attest. This is not to say that you can't make good money out of
them at times - in the same way that an experienced gambler may enter a casino
in Las Vegas with a fair chance of coming out richer, but knowing that whatever
his fortunes, the house will always win. Right now there are some bear ETFs
which have been driven down almost to zero by the big market rally that look
set to do really well if the market heads south soon as expected, even taking
into account the eroding time value of option elements comprising them and
the suspected tendency of the management of these funds to use them as ATMs.

On www.clivemaund.com we will be looking very soon at the associated effect
on the dollar and the Treasury market of a reversal in the broad market and
also at the likely impact of all this on prices of Precious Metals and oil
and on resource stocks. We called
the big rally in copper back in February before it began, and called
the big rally in oil almost at its inception, and then more
recently for copper to enter a trading range and oil to continue higher,
which is what happened, and finally called the latest rally in gold and silver,
although they were expected to perform better than they have on the recent
dollar weakness. A big issue that we will address soon is whether gold and
silver can break out shortly to new highs or whether they will get caught up
in another downwave of deleveraging.

The above represents the opinion and analysis of Mr. Maund,
based on data available to him, at the time of writing. Mr. Maunds opinions
are his own, and are not a recommendation or an offer to buy or sell securities.
No responsibility can be accepted for losses that may result as a consequence
of trading on the basis of this analysis.

Mr. Maund is an independent analyst who receives no compensation
of any kind from any groups, individuals or corporations mentioned in his reports.
As trading and investing in any financial markets may involve serious risk
of loss, Mr. Maund recommends that you consult with a qualified investment
advisor, one licensed by appropriate regulatory agencies in your legal jurisdiction
and do your own due diligence and research when making any kind of a transaction
with financial ramifications.